Did You Know Your Lender Is Also a Borrower?

Businesses seeking borrowed funds need to be cognizant of the cost of leveraged money. Understanding how lenders determine and assess borrowing costs, or interest, gives the owner a tool with which to further evaluate the feasibility of borrowing money.

A majority of the lender’s funds utilized to finance credit investments are obtained from external sources. These sources may include deposit accounts, commercial paper, bonds, or even loans to the lender from other banks, private investors or a government agency. Each source of funds carries a cost to the lender that becomes the initial determinant or basis of the lender’s cost of capital.Lenders must ensure that they recover their own borrowing costs, and charge a sufficient spread over their own costs to provide for a profit on their activity. In a competitive or volatile rate environment, managing the average spread between cost of capital and use of capital is the most crucial function of a successful bank.Lenders also pay depositors for use of their funds. Money market accounts, certificates of deposit, and some other accounts maintained are paid interest for the time the funds are used by the bank. For demand accounts, a bank must provide services in exchange for the use of funds. These various costs are considered when the bank calculates its overall cost of funds.